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We’re near the end of rising interest rates – then what?

A common view is that rates must hold at peak levels until the Bank of Canada feels confident that inflation is fading. Only then can rates fall back to whatever level proves to be the new normal. It might be a year from now until we see rates decline – what’s in store for borrowers until then?

One thing we know is that the burden on borrowers will be unlike anything experienced back in the spring of 2001, the year we last had a prime lending rate higher than the current level of 6.45 per cent. People owed less back then, which means they had less exposure to high rates than today.

Canadian debt payments climb at record pace as interest rates rise

We are living through an economic lab experiment – the first period where high rates meet the high-consumption lifestyle. Expensive houses and vehicles are part of the story, and so are the internet and social media, bank lending policies and the final capitulation of the Depression-era sentiment that debt is bad.

The prime rate is a good indicator of what’s happening with borrowers because it’s used to set the cost of variable-rate mortgages, lines of credit and floating-rate loans. A recent survey conducted through the Carrick on Money newsletter found that almost 46 per cent of recent home buyers had variable-rate mortgages, while 51.4 per cent had a fixed rate and the rest had either a blended loan or no mortgage at all.

If you have floating-rate debt, the past year has been like having the Bank of Canada add seven bricks to the already heavy knapsack you were lugging around. That’s how many rate increases we’ve seen in the bank’s overnight rate in 2022, the most recent of them occurring last week.

Having rates increase multiple times in a year was a shocker. Now, the challenge is to carry your debt until the central bank starts lowering rates. There’s a heft to this burden that was not nearly as pronounced in 2001, the last time the prime was at these levels.

Back then, the ratio of debt to disposable income was around 110 per cent. On Monday, Statistics Canada announced that the ratio in the third quarter of the year was 183.3 per cent. Put another way, Canadians as a group owe $1.83 for every $1 they take home in after-tax pay.

The debt-to-income ratio compares total principal and interest owing against household after-tax income. It’s a rough guide to the household indebtedness for the country, not necessarily the story of you and your friends and family.

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We’ve had a steady rise in the ratio since 2001, with warnings along the way from debt counsellors and personal-finance people about the implications. The response for years from Canadians sounded something like, whatever, thanks for the input. With interest rates as low as they were until early this year, carrying heavy debt loads was comparatively easy.

A flurry of debt repayment happened during the pandemic lockdown period, when people weren’t able to spend as much as usual. But we are still left with a level of indebtedness that eclipses 2001.

Reasons why we’re more indebted include the increased aggressiveness of banks in selling their customers on home equity lines of credit, or HELOCs, and the increased openness of HELOC holders to use these vehicles rather than let them sit idle.

Big increases in house prices are another factor. Numbers from the Canadian Real Estate Association show the average national resale price in 2001 was $172,122, which works out to $269,851 if you adjust for inflation. The average house price in October, 2022, was $644,643, which is almost a bargain price compared with the peak of $816,720 in February of this year.

Also, let’s face it, we’re much more chill about borrowing to finance our lifestyle than we used to be. Persistently low interest rates helped with that, but so did the rise of the internet in the past 20 years.

The internet gave us a marketing dimension unknown to previous generations, and the ability to buy instantaneously 24-7 through online shopping. The internet also facilitates social media that keeps us connected with the lifestyles of friends and family. It’s harder to live a budget lifestyle when you’re bombarded with pictures of other people’s money being spent.

We’ve had periods of rising interest rates before, and borrowers have suffered. But we’re in new territory now. High rates and high consumption are a new partnership in Canadian economics.


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